We recently were contacted by an agent who experienced the pain associated with the failure of a service provider. It appears they forgot to properly pay the federal tax liabilities associated with the administration, reporting, collecting and depositing employment taxes with the appropriate federal and state authorities.

I wouldn’t be writing this if this was an isolated case. Unfortunately, as agencies attempt to manage their costs and use the outsourcing of a common function like payroll, tax fraud cases have multiplied and we know of several agencies that have experienced similar situations.

An agent hires a payroll company and expects that the company will make their tax payments in accordance with the service company’s procedure and the agency’s funds that are provided for the purpose. Not only can the service provider do it cheaper than the agency, most have impressive client lists and a strong history of providing services. But it’s not the actions of the service provider in the first 25 years of a company’s existence that counts when all is said and done – it’s their actions in the last year before bankruptcy! Their current customers rarely know that anything improper is occurring until notices begin coming from the IRS about late payments. And some providers even have the business client change their recorded address so any such notices come to the service provider “for faster handling”

Payroll processing companies serve an important purpose for small and large businesses. They can calculate withholding and take care of reporting and paying social security, Medicare and income taxes. These service providers know the filing deadlines and deposit requirements. Many insurance agents are strong insurance professionals, but are completely bewildered by the accounting process.

You may give your funds to the payroll processor, but you must understand that if he doesn’t file them, it is YOUR primary obligation and liability to do so. Even if you do the right thing and give the payroll company your money, if they don’t apply it properly you are obligated to pay the tax, the penalty and the interest and it might even pierce your corporate veil and become a personal obligation.

If a payroll service makes sense, go ahead and use it. But do a few things that make sense and give you control over the process.

1. NEVER PERMIT YOUR ADDRESS OF RECORD TO BE CHANGED TO THAT OF THE PAYROLL PROCESSOR. In this way, if late notices are posted, they come to you, not to a processor who is already all too aware that they haven’t been paying the proper amounts in a timely fashion.

2. Verify and only use a processing service that uses EFTPS (Electronic Federal Tax Payment System). As an employer you should register for your own PIN and use it to verify payments. The system gives you access to 16 months of payments. Missed or late payments should be an automatic red flag for you.

In the case of the agent who contacted us, he became responsible for tens of thousands of dollars of withholding even though he had already paid that amount to the (now defunct) payroll processing company. He will certainly seek recourse, but will have to pay the cash in the meantime and may be responsible for penalties and interest, as well. In case you think this an isolated case and couldn’t happen to you, link here to an IRS site that describes dozens of similar cases just in 2011:

Tax Fraud Examples re: Employment Taxes